Pathward Financial Inc
SWB:FM7
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Earnings Call Analysis
Q3-2024 Analysis
Pathward Financial Inc
Pathward Financial reported robust financial results for the third quarter of fiscal year 2024, achieving a net income of $41.8 million, translating to earnings per diluted share (EPS) of $1.66. This performance reflects a 14% increase in net interest income compared to the prior year, driven largely by smart asset management and strong loan performance. The net interest margin (NIM) expanded to 6.56%, indicating a healthy improvement, while the adjusted NIM rose to 4.92%.
Looking ahead, the company has narrowed its full-year EPS guidance to a range of $6.40 to $6.60. For fiscal year 2025, Pathward anticipates EPS to be between $7.00 and $7.50, reflecting confidence in consistent growth. The guidance assumes one rate cut by September 2024 and a continuation of risk-adjusted returns strategy to ensure profitability.
Total loans and leases reached $4.6 billion, demonstrating a year-over-year increase of 13%. This growth stemmed from sectors such as working capital finance and government-backed loans, including SBA and USDA programs. In terms of deposits, the company reported $6.4 billion on its balance sheet, an increase of $125 million compared to the previous year. However, off-balance sheet custodial deposits saw a decrease due to seasonal trends.
The introduction of a new technology platform is expected to enhance operational efficiencies within the underwriting process. This investment aims to reduce costs while increasing asset management capabilities, ultimately supporting the company's growth trajectory. The focus on technology underlines Pathward’s commitment to remain competitive and improve service delivery.
Pathward is strategically positioning itself to enhance its risk and compliance infrastructure while fostering growth through partnerships. The management emphasized their goal of maintaining a balanced asset mix, favoring high-return areas, and ensuring that their compliance framework provides a competitive edge in the current regulatory environment.
Despite a strong quarter, management acknowledged challenges arising from the broader market, particularly impacting smaller fintech firms. This backdrop may influence strategic conversations with partners as they seek stability and alternatives within their banking relationships. The company remains selective in its partnership engagements to ensure sustainable growth.
In the latest quarter, Pathward repurchased approximately 287,000 shares at an average price of $52.24. While buyback levels were slightly down from previous quarters, management reiterated their commitment to using capital effectively. The projected payout ratio for 2025 is expected to adjust slightly to between 60% and 70% of earnings, reflecting a balance between growth investments and shareholder returns.
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Ladies and gentlemen, thank you for standing by, and welcome to Pathward Financial's Third Quarter Fiscal Year 2024 Investor Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.
And I would now like to turn the conference over to Darby Schoenfeld, Senior Vice President, Chief of Staff and Investor Relations. Please go ahead.
Thank you, operator, and welcome. With me today are Pathward Financial's CEO, Brett Pharr; and CFO, Greg Sigrist, who will discuss our operating and financial results for the third quarter of fiscal 2024, after which we will take your questions. Additional information, including the earnings release, the investor presentation that accompanies our prepared remarks and supplemental slides may be found on our website at pathwardfinancial.com.
As a reminder, our comments may include forward-looking statements, including with respect to anticipated results for future periods. Those statements are subject to risks and uncertainties that could cause actual and anticipated results to differ. The company undertakes no obligation to update any forward-looking statements. Please refer to the cautionary language in the earnings release, investor presentation and in the company's filings with the Securities and Exchange Commission, including our most recent filings for additional information covering factors that could cause actual and anticipated results to differ materially from the forward-looking statements.
Additionally, today, we will be discussing certain non-GAAP financial measures on this conference call. References to non-GAAP measures are only provided to assist you in understanding the company's results and performance trends, particularly in competitive analysis. Reconciliations for such non-GAAP measures are included in the earnings release and the appendix of the investor presentation.
Finally, all time periods referenced are fiscal quarters and fiscal years, and all comparisons are to the prior year period unless otherwise noted. Now let me turn the call over to Brett Pharr, our CEO.
Thanks, Darby, and welcome, everyone, to our third quarter 2024 conference call. We're very pleased with our results in the first 9 months and continue to execute on what we set out to accomplish this year. Our focus on balance sheet management, led by risk-adjusted returns, and continued evolution of our product offerings have helped us deliver solid financial results. We plan to continue this focus into next year. But before I talk about strategy, I want to give some results from the quarter.
Net income was $41.8 million and earnings per diluted share were $1.66. Results were driven through an increase in net interest income of 14% when compared to the same quarter last year. We also expanded NIM and adjusted NIM, which includes contractual, rate-related processing expense, to 6.56% and 4.92%, respectively. These were both increases when compared to last year's quarter and the second quarter of this year.
Performance metrics remained strong, with return on average assets for the first 9 months of the year of 2.33% and return on average tangible equity of 47.3%. For reference, these metrics were 2.46% and 50.8%, respectively, for the same time period last year. Finally, we are narrowing our guidance range to $6.40 to $6.60 in EPS for the full fiscal year.
On the asset side of the balance sheet, our focus has been to optimize assets and the team has been proven very disciplined in sourcing and underwriting loans that have the highest risk-adjusted returns. We also continue to see a robust pipeline in working capital and government-guaranteed loans, both SBA and USDA.
We put in a new technology system that should create efficiencies through the underwriting process and enhance asset management capabilities to help us maximize our efforts while reducing costs. In consumer lending, we have seen solid originations and continue to co-innovate. We expect to launch additional products as well as ad partners in the future, generating growth for us and enabling our partners to thrive.
In BaaS or partner banking, being a trusted partner to our clients means we can deliver on a number of value propositions. First, we offer experience. We were pioneers in the space, starting our issuing business back in 2004. We believe our deep expertise in payments positions us as a forward-thinking partner with decades of leadership and the capability to expand across multiple solutions, including payments, issuing, credit, tax and now, solutions for financial institutions, which I will expand on in a moment. Second, we provide operational excellence. We believe we have the right people and the right tools. This creates an operating structure that ensures reliable and sustainable programs. Third, we build strong partnerships. We have a high level of commitment to enabling our partners' success and work closely with them every day to ensure they feel supported and valued. Finally, we believe we have a mature risk and compliance infrastructure. We offer partners a scalable platform, led by a governance-focused approach. This has generated a pipeline that we continue to be optimistic about. As a reminder, these deals have a long sales cycle. So anything that we are working on now would be expected to benefit fiscal 2025 and beyond.
During the quarter, we announced the expansion and transformation of our solutions for financial institutions, which previously only provided prepaid cards to banks and credit unions. With this expansion, we can now also provide commercial finance solutions to their business clients that do not qualify for traditional financing or when a product isn't offered. We also provide financial institutions the ability to offer merchant services to their business clients.
Our strategy is to be the trusted platform that enables our partners to thrive. As we get close to the end of our fiscal year and look towards 2025, we will continue to execute on many of the initiatives across the enterprise that were started in 2024 and laid the foundation for growth. First, we need to have not only the right-sized balance sheet but also one with an optimized asset mix. Looking ahead, we intend to continue to favor asset rotation to areas where we believe we have a competitive advantage to deliver higher return on assets. Second, we are regularly investing in technology to ensure that our platform is capable of evolving and scaling as our partners remain on the forefront of innovation and expand their reach with new products and markets. This has been ongoing for years and will continue to be a focus as we grow with our partners. Third, we believe that people and culture are Pathward's most important asset. And as a testament to that, we once again earned the Great Places to Work certification in 2024 for the second year in a row. We intend to remain a Talent Anywhere organization with intentional inclusion efforts to support a workforce spread across the country. Our Talent Anywhere approach is so successful that 4 out of 5 of our top workplace strengths according to our employees were directly connected to Pathward's remote work policies. Finally, we have built a risk and compliance framework and culture that provides us with what we believe is a competitive advantage in our space, and this starts with the tone at the top. This has been and will continue to be a priority for Pathward, especially since the industry is in a more difficult regulatory environment. With this strategy, it allows us to introduce fiscal year 2025 earnings per diluted share guidance in the range of $7 to $7.50.
Now I'd like to turn it over to Greg, who will take you through the financials and discuss our updated and new guidance in more detail.
Thank you, Brett, and good afternoon, everyone. Net interest income continues to be a driver of our results, growing 14% when compared to the prior year quarter. We continue to focus on risk-adjusted returns, which is helping to drive our new production yields higher and increasing the overall yield on the loan and lease portfolio.
New production yield on commercial finance loans and leases in the quarter was 8.58% compared to the quarterly yield on the same portfolio from last quarter of 8.19%. New production yield in the quarter was impacted by a seasonal renewal period in insurance premium finance, which tends to carry a lower yield due to the lower risk. The higher production yields and focus on risk-adjusted returns over the past few quarters have helped expand the net interest margin and adjusted net interest margin in the quarter to 6.56% and 4.92%, respectively, both showing healthy increases over the March quarter.
Provision for credit losses was $5.9 million compared to $1.8 million for the same quarter last year, with the increase primarily stemming from our Commercial Finance division. We are still experiencing a benign credit environment, and the increase in provision largely reflects growth and mix in the Commercial Finance portfolio during the quarter.
Noninterest income declined slightly, primarily driven by a decrease in card and deposit fee income due to lower servicing fee income from reduced levels of off balance sheet custodial deposits when compared to the prior year. Total noninterest expense increased versus the same quarter last year, primarily driven by higher rate-related card processing expenses due to continued deposit growth with our banking partners. Noninterest expense apart from rate-related card costs increased approximately 2% from the last year as the company continues to diligently monitor expenses and responsibly add FTEs to support growth.
Deposits on balance sheet at June 30 totaled $6.4 billion, an increase of $125 million from a year ago. We continue to hold higher levels of deposits on balance sheet to support growth in loans and leases. Off balance sheet custodial deposits held at partner banks as of June 30 totaled $353 million compared to $781 million last year. This declined approximately $840 million sequentially given that these deposits were elevated due to tax season during the second quarter of 2024. We expect deposits to continue their seasonal trend downward, bottoming out around the end of our September quarter.
Total loans and leases at June 30 totaled $4.6 billion, an increase of 13% from a year ago. Growth stemmed primarily from working capital and structured finance, including SBA, USDA and renewable energy. As Brett mentioned, we are seeing healthy pipelines in Commercial Finance as well as in consumer lending. Compared to March 31, total loans and leases balance increased approximately $200 million. We saw increases in insurance premium finance, renewable energy, working capital and warehouse finance.
From a liquidity perspective, we remain in a strong position with approximately $2.5 billion in available liquidity. And as part of our continued goal to optimize the balance sheet and rotate out of securities and into higher earning assets, we expect the securities portfolio to continue drawing down, with close to $300 million of cash flows available for reinvestment over the next 12 months. Finally, during the quarter, we repurchased approximately 287,000 shares at an average share price of $52.24.
We are narrowing our fiscal year 2024 GAAP earnings per diluted share guidance to a range of $6.40 to $6.60. This includes a number of assumptions. First, we expect earning asset yields to exceed those of fiscal '23, given our focus on risk-adjusted returns, continued pricing discipline and securities portfolio cash flows, which continue to be reinvested into higher-yielding loans. With our investment tax credit pipeline, we estimate our effective tax rate to be in the range of 14% to 18% for the full year. And we expect core card fee income to follow normal historical seasonal patterns as has been cased during the first 3 quarters of the fiscal year.
We are also introducing our fiscal year 2025 GAAP earnings per diluted share guidance in the range of $7 to $7.50 per diluted share. This guidance includes the following assumptions: one rate cut in September 2024 heading into our fiscal '25; any additional cuts would have a muted impact on net income given our relatively neutral stance; an effective tax rate of 18% to 22% for the year based on expected investment tax credit volumes and includes expected share repurchases. Additionally, our 2025 guidance also takes into account the success we have had in asset rotation, which we believe will continue to scale net interest income. We also expect our quarterly results to follow our typical seasonality, but be slightly more weighted toward additional earnings in the back half of the year.
This concludes our prepared remarks. Operator, please open the line for questions.
Our first question comes from Tim Switzer with the company KBW.
We appreciate the 2025 EPS guidance. Very helpful. Could you talk a little bit about the expense outlook you have embedded in that? And I'm sure there's some puts and takes depending on how macro trends go on the revenue side. But could you maybe discuss what you guys are expecting there and then what levers would be available to you if revenue doesn't come in like you hoped?
Yes, Tim, sure. I have to touch on the expense guidance for next year. I mean starting point, as you know, we're always going to invest in human capital and technology. I'm actually expecting a fairly muted FTE expansion next year, but we are definitely going to see some. And you're also going to see just normal cost of living adjustments there that will pull through comp and benefits.
On the tech side, I mean, you're going to see probably a fairly consistent increase as we saw this year on the tech side. But we're going to work really hard to self-fund as much as we can for all of that across the rest of the P&L, things like consulting spend, et cetera. So we're going to keep a real tight eye on it. So in total, other than some modest increases on the FTE side and just cost of living and inflationary items, there's really nothing significant I pull forward for you on it.
On rate-related card expenses, though, you're going to have to model that out, just based upon the historic trends you've seen in the last couple of years. You're going to see seasonality in the deposit balances, as you always do. I would also say as part of that, we're really excited about the pipelines on the BaaS side and the consumer finance side or Commercial Finance side. But I would say that the excitement hasn't necessarily drawn into us putting a lot of deposits growth into this yet. We really want to see how the pipeline evolves and starts to pull through. But we have put a modest uptick in BaaS deposits into the latter half of next year that we'll keep you informed on as we go forward.
Okay. Great. That's really helpful. And then could you guys also spend a minute discussing there's a tick up in NPA. Net charge-offs, excluding the tax business, is also a bit higher this quarter. I think you mentioned the commercial finance loan or something. Can you guys talk a little bit about what you're seeing there and what your expectations are going forward?
Yes. On the NPL, NPA ticking up a little bit, just dollar-wise, it's really, I think, more on the consumer finance side. We have one program manager who we typically contractually settle up our -- there's a waterfall that protects us from a credit perspective. We typically settle up with them annually by June 30 and this year, we pushed that out to July 31. So what you're going to see is both an increase in the consumer loans and consumer NPLs related to that. We feel that we're adequately reserved for any potential path toward exposure at June 30. But we expect to wrap it up here in July without any additional exposures.
Okay. Okay, that makes sense. And if I could squeeze in one more, could you guys give us a little bit of guidance or help on what the average off balance sheet deposits should look like in Q4? And then do you expect anything outside of normal seasonality in '25?
For off balance sheet, again, I would point you back to last year as well. I don't think I would see anything untoward in the fourth quarter for off balance sheet. I mean as you know, as I commented in my prepared remarks, fourth quarter is our low point for the BaaS deposits and overall, just seasonally speaking, and that's going to pull forward into the fourth quarter. So I think you're definitely going to see down from where we are, June 30.
And as I mentioned just a few minutes ago, I think for next year, I think I'm really expecting next year's BaaS deposits for the first couple of quarters to trend very similar to the way we did a year ago. But as we get into the back half of next year, I think we're very hopeful that the pull-through on the BaaS pipeline will result in some modest uptick in those BaaS deposits relative to either existing programs with current partners, new programs, et cetera. But it's really back half loaded, so we're not going to see as much impact as you would see if it happened early in the year.
Our next question is from Frank Schiraldi with the company Piper Sandler.
Just on the -- you guys talked about favoring asset rotation still and a mix shift out of securities into higher-yielding loans. It would seem that you still would expect some balance sheet growth into 2025. Just curious if maybe you can give -- size that a little bit. Or is that the right way to think about it in terms of higher-yielding loans growing faster than maybe securities are rolling off the books?
Yes. I mean, again, I would kind of bifurcate it a little bit. I mean early part of the year, first half, at least, I would say, you're going to see historic trends continue, Frank. So if we're growing loans, just focus on the loans. Historically 10% to 15%, I think that trend is going to continue for the full year. From a total asset perspective, I do think we're expecting to see BaaS deposits tick up. Again, both current programs, but back half loaded. I think you're going to see scaling in deposits and total assets that correspond to that. But again, I think it's going to be fairly muted. And as you know, we haven't historically given you guidance on that deposit growth. So I'm probably not going to be any more helpful for you today, but we do expect to see some benefit and uplift on that, in part because if you think about how we fund our third tax season. We typically have some wholesale borrowings to fund that. I'm very hopeful that for next year, we can eliminate some of that and self-fund it through BaaS deposit growth.
Got you. And I guess speaking about strong pipelines, obviously seeing what's going on with some of the smaller banks in the banking as a service business, kind of surprised, Greg, your commentary around modest uptick in deposits in the back half of next year. Is that -- is the pickup more on the fee side in 2025 for BaaS? Or is the pipeline just such that revenues -- deposits and revenues could be kind of pushed out even further from this strong pipeline into future periods, into 2026?
Frank, it's Brett. So I think one thing to think about this is what you're seeing in the marketplace is some trouble with a lot of smaller fintechs that actually won't be in the business. And so there's -- there are a few that are big enough that are profitable that are fleeing the quality. And that's the kind of thing that's in our pipeline that we're looking at. But as you can tell just reading the news, there's some unwinding that's going to be going on. And just because a business existed in one place, it doesn't mean they're going to be able to put it someplace else. And I think that's a little bit of what's happening in this. I kind of remind you that early in this whole phase, we were highly selective on any we would bring in. And that was because we didn't like those businesses anyway. So I don't know if that answered your question, but there are some many things in the pipeline but it's certainly not all the volume that has been out there.
Yes. And just to add to that, too, I mean, Brett's already touched on it. We talked about it, I think, every quarter, but it's a long sales cycle. And I think until we're at the point where we're completing that cycle and announcing deals, I think the reason I use the word modest is until we kind of get through that and we can get some -- let you guys know and the market know that we're closing some of these deals, I think it's appropriate to haircut some of the expectations. We're still very excited about the business, though. And to Brett's point, we're being very selective on what we're letting through the pipeline as well. So again, we're very optimistic, but just being a bit, call it, conservative in terms of how much we pull into the guidance for next year.
Great. And then if I could just ask one more on the buybacks. The buyback levels were a bit down significantly, I guess, quarter-over-quarter. And so capital levels were up certainly where they were year-over-year, I know there's seasonality there. But just how do we think about repurchases here just given the recent run-up in stock? Is there any change? You mentioned, Greg, that 2025 does include expectations on buyback, your guide. But just curious if -- obviously, you've got a lot out there in the current authorization. Just wondering if you guys are maybe tempering that a little bit in terms of activity from what we've seen in previous quarters given just where the stock is.
Yes. I mean as it relates to the current -- to the June quarter, buybacks were down a little bit, but one quarter does not make a full year. So I'd just make that point. We're still very committed to optimizing our capital and high and best use of capital going forward. And I still continue to believe share buybacks falls in that category. I think it's been -- the slight slowdown, just to give you some perspective on it, historically, our buybacks have equated to roughly a 70% to 80% payout ratio in terms of how much of our earnings we put back into the buybacks. For '25, that's likely to come down modestly. And I think that's really to the 60% to 70% payout range versus 70% to 80%.
So when I think about 4 quarters, I think about it moderating slightly. And I think a big part of the driver behind that is we do see the organic growth opportunities. I'd rather have the capital here before we need it. But when I look out the next several years, whether it's building deposit base, being able to deploy that into the loan book, et cetera, I mean I'm looking at this out 3 to 5 years, I'd rather build ahead and get ahead of that a little bit. But I think by the time we get into the middle half -- middle to the latter part of next year, you're likely to see us go back to more normalized levels of buybacks.
Brett, I don't know if there's anything you'd add to that strategically.
No, I think that's exactly right. And we've got some opportunities that are out there and where we need capital for the balance sheet, we'll use it. But 60% to 70% payout ratio was pretty healthy.
Our next question is from David Feaster with the company Raymond James.
Just kind of following up on the partners -- some of the disruption commentary that you talked about in your prepared remarks. I'm curious maybe some of your thoughts on how this impacts partnerships agreements. I've heard that some partners may be looking for backup partners just kind of as a downside protection. I'm kind of curious, how does that impact your negotiations? Do you think that's a positive for the industry? Is that something you're seeing? And how does that impact contracts and pricing and just overall just negotiations?
Yes, that is happening. We're getting those phone calls. There are some whale of partners that are I wouldn't say they're looking for a backup, they're looking for their second one. And that's something we are clearly seeing. We're not terribly excited about being the secondary backup, it's just -- we've got some capacity to do things. We want to use it for things that are going to have a lot of juice coming through it.
And as to agreements, every one of those is custom. And you can have conversations about how that's going to work. There's volumes, there's minimums, those kinds of things. And in some cases, we have agreements where we have a percentage of majority that we expect to get in it. So very much custom. But all those things are happening because more sophisticated program managers have recognized, "Oh, I better have an out or a couple of banks in mind, if I need it, so I can keep doing new programs."
Okay. That's helpful. And then just looking at the slide deck, you talked about implementing a new tech system that's going to create efficiencies. I'm curious, I was hoping you could elaborate on that. What are you looking at? And then I guess with AI being all the rage these days, is there any opportunity for you guys to leverage AI across your platform? And how would you do it?
Well, there's a lot in what you just said, but let me start with what we did in commercial. There are readily available packaged solutions that help with sales process through underwriting, credit management, collateral management, all the way to reporting. And we spend some time and money putting some efficiencies in by installing that in our Commercial Finance group. I wouldn't say it's particularly competitive advantage, but it's the basic tools that will help us there and it will help us with the FTE counts and those kind of things. So we're happy that's in there, and we're starting to reap the benefits of some of that.
I think your comment about AI is correct. But I think that there's a limited view of that we have at the moment. And as you know, everybody has got to be very focused on the data, the info security, the controllers that are in it. We can see some very basic ways where it could be used. I'll give you a simple great example, adverse action reports that are due monthly, people hate writing those things. You can get an initial start with an AI process and then modify it later and make it according to standard. So I mean there's a whole bunch of things that are like that. But we haven't even started to scratch the surface on that. I just hope over time, we figure out how to efficiently use it.
Okay. That's helpful. And then just last one for me. Look, there's still a lot of earnings power that's locked up in the securities book. The good news is that you've got the deposit growth -- you don't have a liquidity challenge. You've got the deposit growth to fund the loan growth that you've got coming. But I guess just given the move in rates and the loan growth outlook that you have, is there any increased appetite for securities sales at this point? I mean you're not hurting for earnings growth, but maybe that could accelerate. I just -- I didn't know if your appetite for that had changed.
No, it hasn't changed, David, to be candid. I mean we might be opportunistic down the road if we saw an opportunity just here and there. But as a practical matter, I mean, when I think about the balance sheet as a whole, we're really just looking at the shape of the curve. And the one thing we haven't touched on yet in this call is when I think about the loan book combined with the securities book, or the ability to rotate into loans just even with that cash flow level, as long as the middle part of the curve stays fairly static, and I think the market does believe that, I think that's really going to be to our benefit and be a real tailwind for us, in addition to the pipelines. But as it relates specifically to loan sales and then recycling that, no, our appetite really hasn't changed on that side.
And just to remind you, I think you know this, but as to the cash flow, I think it's about $300 million a year, right, that we are coming out of the securities book, and so then putting that into the loan portfolio, so sort of self-funding, providing the liquidity to be able to grow the loan book, not counting any new deposits.
That will conclude today's conference call. Thank you for your participation and enjoy the rest of your day.